Did the ECB throw Portugal under a bus thanks to Greece?
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Did the ECB throw Portugal under a bus thanks to Greece?

The ECB appears to be reluctant to aid Portugal's transition to markets because of a flaw in the design of its monetary intervention programme, aimed, in part, to disguise the policymaking failures in Greece, reckons JPMorgan. The Outright Monetary Transactions (OMT) policy is "inconsistent" since it discriminates against current programme members without "full and open" market access.

While eurozone politicians have been accused of enforcing a relentless policy of austerity in Europe, the European Central Bank has been credited for its extraordinary liquidity support for eurozone commercial banks and triggering a bond rally in peripheral Europe with its conditional bond-buying plan for programme countries. However, fears are growing that the ECB is falling to aid Portugal's transition to markets because of a flaw in the design of its monetary intervention programme, aimed, in part, to disguise the policymaking failures in Greece.

In other words, has the ECB sacrificed Lisbon to spare its blushes on Greece, asks Malcolm Barr of JPMorgan?

As we have reported previously, Portugal, despite its heroic fiscal and structural-reform efforts, is besieged by poor growth, a low credit rating and high indebtedness. Although market participants reckon Portugal has a chance to access international capital markets next year, amid growing investor confidence and the expiration then of the current €78 billion programme, at present short-term sovereign yields are still stubbornly high at around 5%, despite a recent rally. High borrowing costs have hiked the cost of corporate borrowing and banking liquidity.

Figures released on Tuesday throw into sharp relief the dependency of the country’s banking system on ECB life-support. According to the Bank of Portugal, domestic banks' ECB borrowing rose for a second consecutive month, up 1% to €56 billion. On the whole, Portugal’s economic reforms and performance have been relatively stable, compared with its shrivelling neighbour Spain at least and, more dramatically, Greece. Nevertheless, anti-austerity protests and calls to relax fiscal targets remain a frequent feature on the economic landscape.

Portugal has issued a bond swap and continues to issue treasury bills, while Ireland has managed to issue a new modestly sized transaction in the primary markets. But, thus far, the ECB has failed to intervene in the Portuguese bond market, with ECB governor Mario Draghi saying that only a country with “full” and “complete” market access, together with a macroeconomic adjustment programme, can benefit from ECB bond purchases. The reason is ostensibly to reduce moral hazard and to preserve the ECB's mandate to reduce "convertibility risk" premia, rather than monetary financing of deficits.

However, this rationale does not wash for JPMorgan’s Malcolm Barr. He has long suspected that the ECB’s rationale has more to do with German concerns, enforcing Greek discipline, and the operational challenges of day-to-day bond purchases. Adding fuel to this argument is the fact that the ECB has made it clear sovereigns that embark on precautionary or full programmes, or the Enhanced Conditions Credit Line (ECCL),can benefit from the Outright Monetary Transactions (OMT), which involves ECB bond purchases in the secondary market.

In other words, the ECB’s conditions for monetary intervention differ for current programme members – Ireland and Portugal – and prospective candidates – Spain, or even Italy. To put it another way, just as Spain or Italy lose market access they could benefit from the OMT, while as Portugal successfully implements reforms and limps towards normalizing its position in international capital markets it is left in the cold.

This “inconsistency” highlights how “the ECB is making it up on the hoof,” says Barr. “What you have is a set of ideas about how to intervene that are not born of a systematic consideration about sovereigns’ circumstances.”

For Barr, Draghi, in a fascinating interview in Der Spiegel, inadvertently reveals the weakness of the ECB’s approach. 

SPIEGEL: Would you really refuse to help a country that does not fulfil the reform requirements?

Draghi: Of course. If a country does not adhere to what has been agreed, we will not resume the [OMT] programme. We have announced that we will suspend operations once a programme country is under review. We will then ask the International Monetary Fund and the European Commission to assess whether the country is keeping the conditions of the agreement, and only after a positive assessment will we resume operations.

SPIEGEL: One only needs to consider the example of Greece currently to get an idea of how credible such statements are. The government in Athens repeatedly broke their commitments to the troika (made up of the IMF, ECB and European Commission) and yet they are now about to receive the next tranche of financial assistance anyway.

Draghi: That is not an appropriate comparison. Greece will not be considered at all for our programme because it is targeted exclusively at countries that finance themselves, now as before, on the capital market. This is something completely different.

A demonstrator jumps over a fire in front of the Portuguese Parliament in Lisbon during a protest. Source: Reuters 

Interestingly, as Barr observes, Draghi’s comments are valuable in what they omit. First, he does not dispute the premise of the questioner’s statement – that the troika has been less than candid when it comes to propping up Greece – and, secondly, he refuses to engage with crucial question of why the OMT was designed to benefit only those economies that benefit from “full market” access. For the analyst, this confirms his suspicions that the monetary programmes were designed to take into account Greece. Barr concludes: “If this is true, then Portugal, and to a lesser extent Ireland, have been innocent casualties of the ECB’s lack of willingness to be candid about its view of Greek programme compliance. The Portuguese authorities have every right to feel aggrieved.”

He reckons the ECB should retool its OMT programme by explicitly excluding Greece – citing the recent debt-structuring and the second adjustment programme as risks for the ECB – in order to boost the OMT's credibility and consistency of approach. This would also yield other benefits: highlighting the ECB’s independence and credible threat of withdrawing support.

Barr adds: “The ECB has not explained at any point why this difference in treatment should occur. One can argue the reality is that it reflects the fact Italy and Spain are large enough that a support effort requires ECB resources, because the EFSF/ESM are simply not large enough.” This argument then exposes that the OMT is “really about sovereign financing amid the difficulties of securing a large enough ESM”.

He continues: “But if the ECB had applied OMT more consistently across the region regardless of size, it would have been on firmer ground in arguing it was motivated by concerns about monetary transmission.” Nevertheless, any shift in approach is unlikely since the ECB is probably loth to concede any technical weaknesses in its approach.

In a press conference outlining the OMT policy in December, Draghi appeared to harden the ECB’s market-access guidelines by stating that intervention in Portugal would only kick in once it assumes “full and complete” access to capital. At first blush, this appear to describe countries that issue benchmark bonds at reasonable levels at every point of their yield curve. But Barr reckons the ECB in practice will demonstrate flexibility. “We are inclined to think support will come sooner in the process of restarting debt issuance rather than later. But putting a precise timescale on that is very hard.”

The idea that the ECB will roll back on its hawkish market-access stance, amid pressure from Portugal and Ireland to aid their transition to the markets, will no doubt make Draghi uncomfortable given the suggestion that the OMT is a negotiable sovereign-financing mechanism between politicians and the ECB.

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